August 16, 2008

Is There Less Funding Or Are Startups Just Cheaper?

As an early adopter, I have an interest in startups. As a software developer and a developer of Web sites and services, I have additional interest in funding and the whole entrepreneur idea. Because of this, I tend to read a few "business" blogs as well as the usual technical fare. One of these blogs is A VC. Recently, Fred Wilson started writing a series of posts on the venture fund economics that is amazing. If you are trying your hand at a startup, I highly recommend you start looking at these posts. Just getting a fundamental understanding of the VC process is helpful in determining whether VC funding is worthwhile to your startup. In his Venture Fund Economics post he concludes with a very interesting point:

Some will read this and suggest that our business is all about swinging for the fences. But I don't think so. There are hitters in baseball, the best hitters in fact, that hit balls out of the park when they are just trying to make good contact. That's how you have to do it in the venture business. You try to make 20 great investments and you work with them closely in hopes that four years in you have six or seven that have home run potential, and after ten years, you maybe hit one or two out of the park. If you try to hit every one out of the park day one, you'll strike out way too much and the fund won't work out very well.

I think this logic can also be applied to startups in general. If you always try to do something that will turn out to be a home run, you will strike out too much. In the technology world, a home run would be a Google competitor, an iPhone competitor or even a Facebook competitor.

So, what if you are just trying to make contact? We have already heard in various places that venture funding is hard to get in general, and even harder in today's economy. Is this discouraging startups? Or are the startups focusing on the "major" technical hub cities? Paul Kedrosky must have been thinking this recently when he found that California is not a big entrepreneur state. Granted this is just an analysis using Google Insights for Search, but it does yield some interesting information. I was not enamored with the search terms that Paul used, so I tried a different set (entrepreneur, startup, venture capital and funding) and found some really interesting results.

Interestingly enough, entrepreneur is not a big search term compare to startup or funding. Initially I thought this could be due to the generic nature of these terms, but the locations tend to match up with significant technical presences. As you can see from the chart, there is an obvious downward trend for all of the search terms. We can assume that this is due to the economy because if you read TechCrunch, Mashable or ReadWriteWeb, you will see plenty of Web sites getting initial startup coverage. In any economy like the one we are in currently, investments suffer and people invest less. Therefore it is likely that venture capitalists are being much more careful regarding what they invest in. Many people wanting to be an entrepreneur are probably taking less risks as well. So, we could be seeing a rise in startups being a weekend job until revenue or major funding becomes a reality.

However, some of these startups do require some significant money in order to operate on a daily basis because cloud computing is not free. Are people getting more angel funding? Following the same logic as the entrepreneur search, I compared the search terms angel investor and angel funding.

Here you can see that angel investor and funding have flat or slightly rising trends. Again there is a definite relation to the major technical locations and the "interest" of searches. Given the trend lines for the "angel" search terms and the comparison to the previously explained trends, it does look like there is more interest in angel funding.

Why would we be seeing this difference in trends, besides the economy? Well, many of the newer web services do not require major hardware infrastructure in order to get started. Cloud computing and even cheap hosting make the hardware investment something that can be put off until there is a true need. Using the cloud is also very cost effective initially because you do not need to hire a server or network administrator. This is all handled for you by the cloud provider. The cloud also gives you the ability to handle spikes in traffic signifcantly better than with a traditional hosting provider. Given these reduced costs, a good round of $100,000 of angel financing could fund a startup for two years. At that point, there could be real revenue being generated or even a venture captial funding round. Money is easier to raise when you are a somewhat proven startup compared to when you first start and only have a few thousand page views per month.

It looks like the combination of the economy, cloud computing and the generally lower technical barrier for new services is creating a new environment for startups. People are finding cheaper ways to get started. Startups are also using the existing information on the web to define more interesting services. So, what is coming next and where do we go from here?